An Empirical Decomposition of Risk and Liquidity in Nominal and Inflation-Indexed Government Bonds

OMI Seminar Series

This paper decomposes inflation-indexed and nominal government bond excess return pre­dictability into liquidity, real interest rate risk and inflation risk. We estimate a systematic liquidity premium in Treasury Inflation Protected Securities (TIPS) yields relative to nom­inal yields. The liquidity premium is around 30 bps during normal times but larger during the early years of TIPS and during the financial crisis 2008-2009. We find that time-varying liquidity premia in TIPS and time-varying inflation risk premia in nominal bonds generate return predictability. We find no evidence that shocks to relative issuance generate bond return predictability in the US or UK.


Luis Viceira (Harvard Business School)

Thursday, May 3, 2012 - 12:30
to 13:30